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A registered index-linked annuity, or RILA, is an annuity that uses a stock market index to determine gains and losses. What sets it apart from other types of annuities is your ability to set the maximum loss you are willing to tolerate. RILAs give you the opportunity to own an investment vehicle with the risk/reward characteristics that meet your overall financial objectives.
A relatively new entrant in the retirement market, a RILA is a deferred annuity that shares some characteristics with fixed-indexed and variable annuities.
RILAs, which were previously referred to as buffered annuities, offer investment growth opportunity with limited downside risk. Because of their limited potential for loss, RILAs can offer protection in an economic crisis, such as the market downturn caused by the coronavirus pandemic.
Compared to fixed-rate annuities, RILAs have a greater potential for significant returns and may be an option for people who have previously looked to indexed annuities.
How It Works
A RILA allows you to limit your losses during a down market. In return, your gains are capped to the same extent when the stock market goes up.
You determine your exposure to risk and your potential return by setting either a floor or a buffer.
A RILA floor is the maximum percentage loss you are willing to absorb during a down market. Any losses beneath the floor are absorbed by the RILA provider.
A RILA buffer is a percentage of loss that you do not wish to absorb. You are exposed to losses to the extent that the linked market index losses exceed the buffer.
Your upside gain is capped to the same extent that your downside loss is limited.
In this example, a RILA is linked to the S&P 500 index, which tracks the price movements of the 500 listed stocks with the largest capitalizations. When you buy this RILA, you are not investing in the underlying stocks in the index. Rather, the index merely indicates percentage gain or loss.
You can set a floor to limit the maximum amount of loss you are willing to accept. For example, suppose you set the RILA floor at 10 percent. This protects you from losses exceeding 10 percent. So if the linked index falls 15 percent, your loss is only 10 percent. Your gains are symmetrically capped at 10 percent.
A floor makes sense if you are unwilling to accept any losses beyond a certain point, even if that prevents you from gaining beyond the cap.
A buffer protects you from a percentage of loss. For example, suppose you set a buffer of 10 percent and the index declines 15 percent. Your loss is 15 percent minus 10 percent, or 5 percent.
Gains are reduced by the same buffer amount. If the index rises 30 percent, your gain is 30 percent minus 10 percent, or 20 percent.
You might prefer a buffer to a floor if you are willing to accept more risk. A buffer exposes you to potentially higher risk but also larger return.
What Are the Benefits of a Registered Index-Linked Annuity?
RILAs can help you accumulate money for retirement and other long-term needs. In addition to offering protection and growth options, this type of annuity allows you to accumulate growth without paying taxes and fees until you make a withdrawal. You also have the option to convert the annuity into a stream of income payments in retirement.
Potential for Market Growth
You participate in the market upside up to the extent set by the floor or buffer. By purchasing a RILA, you avoid the risk of investing directly in stocks.
Limitation of Downside Risk
You set the amount of downside protection you require. You have the option of setting a floor or a buffer. As described above, both offer downside protection, albeit in different ways.
Typically, RILAs let you accumulate growth without a fee. You only pay fees on withdrawals or if you surrender the RILA during the specified early withdrawal period.
You only pay taxes when you receive distributions from a RILA. The remainder of the RILA continues to grow tax deferred.
- Fixed period:
- You receive an income stream for a selected time period. The shorter the period, the larger the periodic payout.
- Payments continue for the remainder of your life. You cannot outlive the annuity.
- Life with a minimum fixed period:
- Like a life payout option, except a certain amount is guaranteed to be paid out, even if you die shortly after purchasing the RILA.
- Payments continue for the remainder of your life and the life of the named survivor, typically a spouse. Often, the survivor’s payments are 50 percent of the original amount paid to the first to die.
How Is a RILA Different from a Fixed-Rate Annuity?
While both fixed-rate annuities and RILAs can be used to supplement income in retirement, the two types of annuities carry different levels of risk.
A fixed annuity is a low-risk product that guarantees a fixed interest rate on contributions to the annuity over a specified period of time. This type of annuity is not linked to the performance of a portfolio or another investment and can be a good option if you want a predictable and reliable income stream with low fees.
Unlike a fixed annuity, RILAs expose you to some market risk and let you participate in market gains. A RILA may be your preferred choice if you plan to retire within the next five to seven years or if you are already retired. Because you can select a RILA’s risk/reward characteristics, you can use it to strategically supplement other income streams to help meet your unique retirement needs.
On the other hand, if you are at least 20 years from retirement, you may prefer a variable annuity. Your long investment horizon lets you take advantage of the market’s long-term trends. You also have time to recover from bear markets and investment mistakes. Be aware that variable annuities usually have fees higher than other annuity types.
To help you select the right product for your individual needs, it’s important to review how the different types of annuities align with your risk tolerance.
- Fixed annuity:
- You receive a guaranteed interest rate over the time period specified by the payout option.
- Fixed-indexed annuity:
- You receive a guaranteed interest rate as well as additional returns if the linked index increases in value. Payments continue over the time period specified by the payout option.
- Registered index-linked annuity:
- Returns are not guaranteed, but rather are linked to a stock market index with capped gains and limited losses.
- Variable annuity:
- Gains and losses are tied directly to the underlying investment portfolio, which can be equity and/or fixed-income funds. You have no protection from downside loss, no cap on upside gain and no guaranteed return, unless you purchase a rider, such as a guaranteed minimum income benefit (GMIB) rider. Upon annuitization, payments continue over the time period specified by the payout option.
A qualified professional can help you identify the annuity that best fits your wealth plan and provides the greatest strategic benefits.
How are RILAs Regulated?
RILAs, like other annuities, are insurance contracts, so they are subject to state insurance commission regulations. The states have overarching governance and standardization from the National Association of Insurance Commissioners, or NAIC. These regulations are in place to protect consumers, and to ensure annuity providers are only issuing products that meet clients’ financial goals.
The NAIC has a Life Actuarial (A) Task Force that was formed to “identify, investigate and develop solutions to actuarial problems in the life insurance industry,” according to the NAIC. A new subgroup of this task force, the Index-Linked Variable (A) Annuity Subgroup, was created in 2021 to provide recommendations specifically for these annuities.
5 Cited Research Articles
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- Hilton, J. (2021, June 17). NAIC Forms Work Group To Better Regulate Index-Linked Annuities. Retrieved from https://insurancenewsnet.com/innarticle/naic-to-form-work-group-to-oversee-index-linked-annuities
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- National Association of Insurance Commissioners. (2020, May 5). Annuities. Retrieved from https://content.naic.org/cipr_topics/topic_annuities.htm
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- National Association of Insurance Commissioners. (2021). Index-Linked Variable Annuity (A) Subgroup. Retrieved from https://content.naic.org/cmte_a_ilva.htm